CEO Pay Ratio and Reasonable Compensation Estimates

by Malak Kazan, CECP, CCP, CBP, GRP 22. October 2013 15:25

The Dodd Frank rule requiring public companies to report CEO pay ratio relative to employee pay was approved by the SEC in a 3 to 2 vote and is currently in a 60-day comment period open until December 2, 2013.  Once finalized, as early as 2016, publicly-traded companies will need to disclose the CEO’s annual compensation relative to employee annual median compensation and express this comparison as a ratio.  Company exemptions are those covered by the JOBS Act (i.e. emerging growth), foreign private issuers, and small reporting companies.  Some of the broader operational definitions for implementing this rule follow:

  • Companies will have to report the ratio in annual filings that also require executive compensation disclosure like Proxy Statements or Annual Reports. 
  • The workforce covered by this rule are permanent full-time employee, part-time, seasonal, and temporary employees; excluded are consultants, contractors, or temporary staff hired through a third party as leased workers.
  •  The compensation components included in the calculation will mirror the Summary Compensation Table pay elements disclosed for the CEO to determine the annual median total compensation of the employee.

To actually perform the ratio calculation, the proposed rule addresses the concerns of many global companies by allowing statistical sampling of employee population in the more “difficult to report” business locations (i.e. due to data privacy regulatory compliance that may be cost prohibitive, or possibly the lack of critical mass in a new or small operation where the resultant statistic would not be meaningful).  The flexibility in this requirement allows the company the option of using another consistent measure for reporting the pay ratio that can be based on actual compensation paid and/or estimates, if necessary.  The example cited in the proposed rule is selecting cash compensation as “another consistent measure” for locations, pulling the median value from the sampling for that location after smoothing out the observation for outliers, then calculating the total compensation for that employee to be used in the pay ratio.

ERI Economic Research Institute has been providing reasonable compensation estimates to more than 5000 subscribing companies for over 25 years.  A compensation estimate is essentially the output of statistical methodologies that use regressions analyses techniques (both single regression and polynomial regression) derived from robust datasets.  ERI’s Assessor Series provides estimated cash compensation, which is the sum of the base salary and cash incentive where the incentive data represents an average of all employees in the job, including organization data where no incentive or cash bonus was paid. The Assessor Series includes benchmarking tools for over 6000 executive and non-executive benchmark jobs. 

To calculate the median compensation, most companies can rely on the country-specific tax reporting document, such as the W-2 in the U.S., which is a data source that is readily available to organizations.  The proposed ruling allows flexibility in formulating the assumptions and methodology while also requiring such information be disclosed in public filings.  With some of the lead time to plan for this requirement, companies will need to establish a consistent and reasonable approach with thoughtful transparency to shareholders that will generate valid and reliable median compensation values and related ratios. 

To learn more about compensation estimates and related compensation analytic solutions, visit www.erieri.com or call 1-800-627-3697.